Moreover, you may need a different form of organization at different times in the life of your business. So don't be afraid to change your form of business if your needs change.
This article discusses the following four topics:
- The Big Picture (profits & losses, federal & state taxation)
- Forms of Business (the six business organizations for federal tax purposes)
- Tax Factors (the taxation of profits and losses)
- Business & Legal Factors (number of shareholders, raising capital, cash-flow issues, limited liability, ease of incorporation)
This article does not discuss various state-specific issues or the forms, documents, and process for incorporating your business. For this information, I refer you to
- How to Incorporate a Business, which covers general information about forming a corporation,
- How to Incorporate in a State, which links to articles about how to incorporate in various states, and
- How to Form an LLC, which covers how to create a limited liability company.
The Big PictureThe decision about which form of business is best for you depends on a lot of factors. Primarily I will discuss the tax-implications of various forms of business. One of the more important things to consider is how your business income will be taxed over the long-term.
Hopefully your business will be profitable. New businesses often encounter a period of time where expenses are larger than income, creating a net loss for the business. For each type of business, profits are taxed in slightly different ways and losses are handled in slightly different ways.
All of the forms of business organizations can be separated into two groups: corporations where tax is assessed at the corporate level and "pass-through entities" where tax is assessed at the shareholder level. The phrase "pass-through entity" means that profits are not taxed to business entity. Instead, the profits (or losses) are imputed as income (or "passed-through") to the owners. Each owner reports his or her share of profits or losses on his or her individual tax return.
Here's the breakdown of the various types of organizations.
Organizations that are taxed at the corporate level:
- Limited Liability Companies taxed as corporations, and
- Non-profit organizations
Organizations that are taxed at the owner level ("Pass-through entities"):
- Sole proprietors,
- Partnerships, and
- LLC/LLP/PLLC/PLLP taxed as partnerships